Monday, May 14, 2012

Updated October 22nd, 2012Some
months back, I posted an article that outlined the dangers of the world's
overall sovereign, corporate and household debt levels in an posting entitled
"The Debt Break Over Point - When is too
much, too much?". In this article, I noted that debt is a two-edged sword;
while it is needed for economic expansion, debt growth of all types can quite
quickly mount to levels that are unsustainable. When these levels are
reached, further increases in the amount of debt can actually cause economic
contraction. The world is finding itself very close or past the point of
no return; the level of the world's total debt load has risen relentlessly over
the past three decades from 167 percent of GDP in 1980 to 314 percent of GDP in
2010.

Over
the past two years, the mainstream media has devoted many pages and a great
deal of airtime to two debt issues; the increasingly alarming sovereign debt
issue facing the world and the increasing levels of consumer indebtedness in
Canada and other nations. One issue that has pretty much received a pass
has been the level of corporate debt. Fortunately, Standard & Poor's
has now released an analysis showing where the dangers of corporate debt may
lie in the coming years in their "The Credit Overhang: Is A $46 Trillion
Perfect Storm Brewing?".

Standard
& Poor's opens by noting that, over the period from 2012 to 2016, there is a huge "global wall" of nonfinancial corporate debt
maturing. On top of that, over the five year period, corporations will
require additional debt to fund capital expansions. Over the five year period,
S&P estimates that corporations will require between $43 trillion and $46
trillion in debt refinancing and new debt. To put this absolutely
stunning number into perspective, according to the Economist Global Debt Clock, the world's current global public
debt is $48.9 trillion as shown on this screen capture:

Here
is a chart showing the new corporate debt that will be required over the next
five years by geographic area (in millions of USD):

In
total, the world's nonfinancial corporations will require between $12.875
trillion and $15.986 trillion, depending on how quickly corporate debt grows
compared to growth in GDP. Keep in mind that the entire sovereign debt of
the United States, the world's most indebted nation in nominal terms, is $15.7 trillion.

Here
is a chart showing the current level of outstanding nonfinancial corporate debt
by geographic region and by type of debt along with the 2011 GDP for each
region:

Standard
& Poor's estimates that three quarters of this outstanding debt will come
due during the five year period between 2012 and 2016 with the developed
economies of Europe, the United States and the United Kingdom responsible for
55 percent of the total. China's nonfinancial corporate debt, while large
compared to its GDP, consists largely of loans from state-owned banks to
state-owned enterprises.

Here
is a bar graph that quite graphically (weak pun) shows the height of the
"debt wall" with new debt in green and the amount of debt rolling over in grey:

S&P
states that the demand for corporate debt could overwhelm the world's banking
system as banks look to restructure their weakened balance sheets (particularly
in Europe) to meet capital ratios and liquidity requirements. On top of
that, the world's bond holders are looking for safe-haven fixed income
investments; as they flee to the shrinking supply of triple-A-rated bonds, they
may choose to ignore all but the least risky new corporate issues. This
may result in corporations having to raise yields on their new and refinanced
debt to attract sufficient buyers if they choose the bond route for refinancing.

The report suggests that the global banking system and the world's bond
markets will be able to supply the necessary capital for corporations to
continue to finance themselves, however, the current situation is extremely
fragile. The ever-increasing levels of sovereign debt have trimmed
government's ability to bail out the system as they did in 2008 - 2009 because
they are dealing with their own debt and deficit demons. Extreme levels
of volatility in government debt interest rates in Europe are a greatly
complicating factor for corporations in that geographical area. As I
noted in this article, we could well be entering a perfect credit storm where
both governments and corporations (and by extension, households as the debt
problem trickles downward) are unable to find funding; corporations in
particular could find themselves "crowded out" of the world's credit
markets. Here is a quote from the S&P report which nicely summarizes the
issues facing the corporate world:

"Will
capital market constituents have the capacity to provide the new
"bricks" required to extend the maturity wall and spark economic
growth? Much will depend on the continued ability of banking system regulators
to pilot a path through the minefield that lies ahead. Governments and central
banks globally have utilized many financial tools in their arsenals to
stabilize the financial system and strengthen bank balance sheets. In
conjunction with the global financial markets showing signs of stability,
monetary and fiscal policies quickly shifted to focusing on restoring economic
stability and growth. However, this highly accommodative monetary policy,
centered on expanding the monetary base and maintaining artificially low
interest rates, is likely to produce only a fragile recovery at best, and could
easily be thrown off course at any moment. Key risks that could challenge the policy
consensus include a backlash to the austerity measures introduced in debtor
countries in Europe, escalating oil and commodity prices (possibly triggered by
further geopolitical unrest in the Middle East), and a potential material
slowdown of growth in China." (my bold)

The
greatest risk appears to be the $13 to $16 trillion in new debt that will be
required over the next five years. This problem appears particularly
acute in Europe which has a much less developed corporate bond market than what
has been in place in the United States over the past three years. American
debt markets have proven that they can supply $400 billion per year of new
funding, that is in sharp contrast to Europe which has exceeded the $100
billion mark in only two years of the past ten. This may force European
corporations to look to the American debt market for financing.

In
summary, here is the second last paragraph from the report:

"Lastly,
much of the funding available for corporate borrowers over the past few years
has depended on the utilization of many financial tools by central banks to
mitigate problems, stabilize the financial system, and spark an economic
recovery. If the spectre of inflation rises, we could see a tremendous increase
in funding pressures. So, at best, we are currently at a fragile peace. At
worst, we have created the makings of a perfect storm for the future." (my bold)

4 comments:

I have a couple of independent thoughts on the matter. First off, the talk of "the sky is falling" is meant to resonate with paranoid people - to scare them in order to manipulate them in to doing what the powers that be want them to. All countries are creating debt, so I don't buy that the sky is going to fall per say. Money (currency) is nothing more than a mechanism to put a value on productivity. The distribution of that value has become based on whoever has the most influence on political policy.

Secondly, debt has been created as a way to steal value from the future and bring it into the present. For example, owning a house you cannot afford to pay cash for means you have to borrow (in effect, from the future) to get it now. In order for that value to be created as additional value so that you are not "stealing" from the future, productivity needs to increase. The problem we have today is that the value of that productivity increase is not being distributed equitably.

For example, manufacturing has always been a productivity engine. It distributes the value from the owners down through the employees. When the manufacturing process becomes more automated, employees are replaced by machines (robots, computers, etc.) Machines don't get paid, they don't buy houses, etc. (They do consume energy - but that is a separate topic.) The machine replaces far more people than it takes to keep it running, otherwise, it wouldn't be worth the cost. This creates a relative imbalance (compared to anytime in history) of the distribution of the value of productivity.

More of the value of the productivity increase is going to the relatively fewer number of people involved, and an increasing share of that is going to the owners. This leaves a greater number of people out of the loop.

The statistics on wealth inequality is proof of this trend. A much greater share of total income that is created, is going to a relatively smaller group of people. This is the reason why debt is a problem. Debt takes an equal share of future productivity value and distributes it unequally. At least, that is the way it seems to be working out.

Thanks for this excellent article. A lot of Chinese non-financial corporate debt is owed by state owned corporations to state owned banks. What happens if these loans go bad? The state owing itself money? A lot of the loans were used for development, building houses and infrastructure that remain largely empty and unused. If the houses remain unsold by the time the debt used to build them matures, how will the debt be repaid?

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.